The voices of Tax Policy Center's researchers and staff
While the Tax Cuts and Jobs Act significantly cuts taxes for US corporations, it may have created so much uncertainty that the promised benefits of those tax cuts—new productivity-enhancing investment and a shift of foreign capital to the US—are being delayed.
At last week’s National Tax Association’s annual policy conference, much of the conversation revolved around this high level of uncertainty. Tax practitioners as well as academic economists reported that large multinational businesses—and their tax advisers-- do not yet understand the new law, and thus are reluctant to commit to major investments.
On one hand, corporations are pleased with the TCJA’s tax rate cut from 35 percent to 21 percent and it’s more generous tax treatment of some business investment. But the law’s new regime for taxing the profits of US-based multinationals has tax experts scratching their heads.
Unique and untested
The law shifted the US from a hybrid worldwide corporate tax system, where profits of US-based firms were subject to US tax no matter where they were earned, to a version of a hybrid territorial system, where the US taxes only profits made in the US.
But the TCJA’s modified territorial system is unique and untested. It includes at least four changes that introduce new and complex rules for multinationals, three of which come with their own acronyms:
There is a new US tax on Global Intangible Low Tax Income (GILTI) from foreign affiliates in excess of 10 percent of the firm’s tangible overseas capital investment (less depreciation). Through 2025, the minimum rate on that income is 10.5 percent, though companies can claim an 80 percent credit for foreign taxes attributable to GILTI. As a result, the tax applies to income in any country with an effective rate of less than 13.125%. After 2025, GILTI will apply in countries with corporate rates of less than 16.406%.
Little clarification this year
Another provision is a deduction for Foreign Direct Intangible Income (FDII). It allows US corporations to deduct a portion of their overseas income from intangible assets held in the US, such as foreign sales of a drug with a US-based patent. The deduction reduces the effective tax rate on this income to 13.125% through 2025 and to 16.406% after that.
Then there is the Base Erosion Alternative Minimum Tax (BEAT). It is a complicated alternative minimum tax of 10 percent (12.5% after 2025) on a modified taxable income base that disallows deductions for payments from US parent firms to certain related foreign parties.
Finally, the TCJA imposes a one-time tax on pre-2018 profits of foreign affiliates at rates of 15.5 percent for cash and other liquid assets and 8 percent for non-cash assets. The tax is collected over eight years. This one has no acronym but it brings its own complexities. For example, nobody seems to know exactly what cash is.
Where did the cash go?
Treasury won’t propose regulations aimed at clarifying some of the ambiguity until late this year. But even that first round of proposed rules will fall far short of relieving all the uncertainty.
For example, how will the new law fit with the bilateral tax treaties the US has with scores of other countries around the world? Are the BEAT and FDII provisions legal under the rules of the World Trade Organization? And, given rising deficits and the possibility that Democrats will win control of at least one house of Congress in November, how sustainable are the TCJA’s business tax cuts? For instance, many business tax experts expect Congress to raise the corporate rate to something like 25 percent sometime over the next five years.
All this uncertainty may help explain how corporations are responding to the new law. Five months in, many large corporations have enjoyed a tax windfall and big earnings growth. But they don’t seem to know quite what to do with the money. They distributed some to workers in the form of raises and bonuses, through less than the proliferation of high-profile press releases from firms and the Trump Administration implied.
Firms are distributing some of that new cash to shareholders in the form of stock buybacks and dividends. So far this year, US corporations have repurchased more than $267 billion in stock. But firms often repurchase shares when they don’t know what else to do with cash.
That may be because corporations think we are near the top of the business cycle, major changes in supply change management make it possible for them to fill orders without new investment, rising interest rates have made purchases less of a bargain, or firms just have no good investment targets.
Or, maybe, it is because they don’t really understand the consequences of the 2017 tax cuts and how much those changes in the law will change their after-tax incomes.
It is axiomatic that business want certainty in tax law, especially as it affects capital investment, where major projects may take five years or more to conceive, design and build—and may remain in service for a decade or two after that.
The pre-TCJA corporate tax law was deeply flawed. The US rate was not competitive. The US system drove firms to make non-economic decisions aimed only at gaming tax laws. But at least business understood the law. They could plan and make decisions relatively confident that the law would not change in surprising ways.
Now, Congress and President Trump have turned that world upside down. They’ve given business big new tax cuts combined with a healthy dose of uncertainty. And corporations, it seems, don’t quite know how to react.
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Rogelio V. Solis, File/AP Photo